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Compute lower and upper arbitrage-free price bounds of a European put option written on a non- dividend-paying stock with strike price $40 and a remaining time to maturity of 3 months. The current spot price is $38. Assume that the risk-free interest rate is 10% p.a. (with continuous compounding).

Compute lower and upper arbitrage-free price bounds of a European put option written on a non- dividend-paying stock with strike price $40 and a remaining time to maturity of 3 months. The current spot price is $38. Assume that the risk-free interest rate is 10% p.a. (with continuous compounding).

Essentials Of Investments
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
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Compute lower and upper arbitrage-free price bounds of a European put option written on a non- dividend-paying stock with strike price $40 and a remaining time to maturity of 3 months. The current spot price is $38. Assume that the risk-free interest rate is 10% p.a. (with continuous compounding).
Transcribed Image Text:Compute lower and upper arbitrage-free price bounds of a European put option written on a non- dividend-paying stock with strike price $40 and a remaining time to maturity of 3 months. The current spot price is $38. Assume that the risk-free interest rate is 10% p.a. (with continuous compounding).
Expert Solution
Step 1: Introduction

A put option gives the right but not the obligation to sell at the strike price. 

To ensure there is no arbitrage, the price limits of a put option can be determined with the formula below:

U p p e r space b o u n d space P u t space p r i c e space less or equal than P V space o f space s t r i k e space p r i c e L o w e r space B o u n d P u t space p r i c e space greater or equal than P V space o f space s t r i k e space p r i c e space minus space s p o t space p r i c e


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